Another good year is almost certainly in prospect in 1998 for overseas investment in UK property, even though it seems unlikely that 1997's record inflows can be matched. There is evidence that property funds have been riding the economic cycle. Britain as the first of the major European economies to move out of recession, attracted the first wave of property buyers from overseas. Having hitched a ride on the UK growth, some of these investors may now be turning their attention to other European economies which are still at an early stage in the cycle. But meantime the UK is attracting new or increased inflows of overseas property funds, notably from Israel, South Africa and the US.

The massive overseas inflow into UK property in 1997 saw direct overseas investment up to £3.8bn by the end of November, according to international property advisers DTZ Deb-enham Thorpe. This already far ex-ceeds the £2.16bn ($3.6 bn) achieved in the whole of 1996 and even the all-time record of £3.27bn in 1990.

But 1990 was the year before the worst post-war slump in the UK's commercial property market got under way. Does the renewed build-up in overseas interest suggest that the market is again approaching one of its cyclical peaks?

On balance, that is probably unlikely. The economic and interest rate climates are very different from those at the start of the decade. However, the fact that the UK is further into the growth phase of its economic cycle than most continental European ec-onomies has been reflected in property performance. Office rents in London's West End have risen by 38% over the period 1993 to 1997 and in London's financial sector the growth has been even greater according to DTZ Debenham Thorpe. In Frankfurt on the other hand, the same period saw an overall decline of 20% in office rents and the decline in Paris was over 14%.

Admittedly, London office rents had often more than halved in the period 1989 to 1993 and were thus resuming growth from a very low base. But overseas investors who had the nerve (which many of their UK counterparts lacked) to bargain-hunt during the recession and continue their buying subsequently have jumped on the property cycle at the right time. It would not be surprising if some of them now wanted to move on.

Assuming total overseas investment in UK property reaches £4bn or so for 1997 as a whole, it seems unlikely that this sort of level could be sustained in the long term. Peter Evans of DTZ Debenham Thorpe suggests that the important German open-ended funds may already be extending their interest to other areas, notably Holland and the US. But a figure of £2.5bn or so for annual overseas investment in UK property looks sustainable into the future.

German open-ended funds have enjoyed phenomenal growth over the past six years, during which period their total inflow has been in the order of DM60bn. The only fly in the ointment is a fear that their tax advantages may be curtailed in the German government's quest for budget savings, thus restricting their growth. But in the meantime their investment in UK property has mirrored the growth in their own liquidity. Germany has been the main source of overseas funds for UK property investment in recent years, accounting for £1 bn of 1996's £2.16bn total. The open-ended funds have been the most im-portant factor and have been notable for their large individual purchases. Among the leaders, DESPA (which in 1996 bought the Lloyd's building in London's Lime Street for £180m) announced in 1997 a £90m investment in an office development by property group Helical Bar in London's Wood Street. London property still accounts for almost two-thirds of overseas investment, but interest outside the capital is increasing.

It comes as no surprise that Holland should be attracting some of the interest that the German funds can spare from the London market. The ROZ/IPD Netherlands Index showed a benchmark total return of 1 l . 5% in 1996 against 10.4% the previous year. This was the second year for which the index had been published and it now includes industrial properties (though these enjoy a very light weighting in Dutch institutional portfolios). The index is produced on similar lines to Investment Property Databank's UK property indexes and reflects the performance of about three-quarters ofthe property owned by fnancial institutions and property companies in Holland.

However, the composition of these Dutch property portfolios is quite different from that of the IJK institutions by virtue of its large residential content. Residential property accounts for almost half ofthe total, with offices accounting for 25.1% and retail property for 17.3%. Mixed-use property accounts for 6.5% and industrial for only 1.6%. And in 1996 it was residential property that made the running, with a total return of 14.5%, of which capital growth accounted for 7.6 percentage points. Retail property and offices showed capital growth of less than 1%, with the income producing most of the total returns of 8.8% and 9% respectively.

This contrasts strongly with the position in the UK, where retail property showed the best total return of l l % in 1996, helped by growth of 4.2% in rental values and a very small reduction in the yield basis of valuation. Again, the figures are from IPD. Underlying returns across all classes of business property in the UK matched the long-term average of 9.6%. Rental values across the board rose by 3.1 % But many commercial properties in the UK are still "overrented" after the fall in rental values during the slump at the beginning ofthe decade. In other words, thanks to the "upward only" clause in rent reviews, tenants whose rent was set at a high level in the boom period of the late 1980s find themselves paying more than today's market rent for their property. The recovery in rental values is not fully mirrored in an increase in capital values until rental values catch up with the rent that is actually changing hands.

Nevertheless, the improvement in UK property values continued in 1997. IPD's review for the third quarter of the year showed the total return running at an annualised rate of 13.8% up to the end of September.

Investors who are bewitched by indexes should, however, take a look at IPD's recently published Property Funds Review which analyses performance over one year and 10 years. Expertise in selection of individual investments can produce returns way above the average in property and lack of expertise can cause you to underperform severely. On IPD's analysis, 60% of the variation in ten-year returns is accounted for by selection of individual properties and only 40% by asset allocation between the different main sectors of the market. However, in short- term crises asset allocation may assume a greater importance, as any investor who was overweight in London offices when the market went into free fall early in the decade will know.

Micheal Brett is a freelance journalist and author of Property and Money""